The average cash LISA pays 3.26%, trouncing the paltry 0.78% offered in July 2022, data from Moneyfacts reveals.

This represents a four-fold increase or a 317% rise in just a year, off the back of consecutive hikes to the Bank of England base rate which now stands at 5.25%. But with rates expected to climb further, it could push cash LISA rates up too.

Currently, the market-leading cash LISA is offered from wealth app Moneybox which has raised interest rates from 0.85% in July last year to 4% today.

The cash interest on top of the Government’s 25% boost to savings under the LISA scheme could help bring forward first-time buyers’ step on the property ladder, and provide those saving for retirement more cash in their nest eggs.

But what are LISAs, how do they work and what do you need to know about them? Our back-to-basics guide gives you a rundown of this hybrid property and pension savings scheme.

What is a Lifetime ISA?

The LISA is a specific type of savings account which can be used to help buy a first home or for retirement.

It was launched in April 2017 and can be opened by anyone aged 18 to 39 but funds can only be accessed penalty-free to buy a first property, from the age of 60, or if the holder is diagnosed with a terminal illness with less than 12 months to live (see more on withdrawal penalties below).

Savers can deposit up to £4,000 each year in cash or stocks and shares (or both) until the day before your 50th birthday with the Government paying a 25% bonus on top of this amount. This means if you were to put away the full £4,000 in the year, you would have £5,000 saved as the Government top-up equates to £1,000.

There’s no maximum monthly contribution so you can save as little or as much as you want each month as long as you don’t exceed the £4,000 a year limit.

Over the whole time period (from the age of 18 to just before 50) you could put away £128,000 with the Government adding £32,000 to your savings. If you use the account to buy a first home, you can then continue to use it for your retirement savings.

And as this is an ISA, it means all interest, growth and earnings are tax-free, on top of the 25% Government bonus.

But, before you get carried away, you need to be mindful about the restrictions, including the £450,000 maximum value of the house you can buy nationwide, and the purpose eg to live in, not a holiday home, for instance.

As house prices have soared, this maximum £450,000 house price limit has been criticised for not changing over the years, with many groups calling for it to increase.

However, between 2022/23, 56,100 people used their LISA to purchase a first home, with the average amount of £13,877. In 2021/22, 662,000 LISAs were subscribed to, with a total of £1.7bn being deposited, HMRC statistics reveal.

What are the Lifetime ISA rules?

You can have a cash LISA and a stocks and shares LISA, but you can only open one and pay into one each tax year.

On the property side, you need to be a first-time buyer and take out a mortgage. If you’re in a couple and both have the LISA, then both parties can use the LISA savings and bonus, but the house price value isn’t doubled. You can still only buy a house worth up to £450,000. If the property value exceeds this, you can access your cash but it comes with a penalty.

The LISA allowance forms part of the overall £20,000 annual ISA allowance and HMRC confirms that the Government bonus doesn’t count towards the £4,000 LISA allowance, or the £20,000 ISA allowance. This means technically you can actually have £21,000 in these ISAs without breaking the rules.

Now, the LISA superceded the Help to Buy (H2B) ISA which was launched in 2015 but which closed to new applicants in November 2019. However, anyone with one can carry on saving into it until 30 November 2029.

Savers are allowed to hold both a H2B ISA and a LISA, but they can only use the Government bonus from one of the schemes when buying a first home.

If you’re a couple with one half holding a H2B ISA and the other holding the LISA, HMRC confirms that as long as you’re both first-time buyers, you can use the bonus from both schemes.

What are the LISA penalties?

If money is taken out for reasons other than those allowed, the holder will pay a withdrawal charge of 25%.

While this sounds like the Government is just clawing back its bonus, the 25% charge is applied on the whole amount so it eats into your contributions.

As an example, someone with £4,000 saved, with the £1,000 Government bonus would face a penalty of £1,250 for early access.

This penalty applies to anyone who wants to access their cash within 12 months of opening a LISA product too.

And, in light of the cost-of-living crisis and high inflation, the numbers of people having to dip into their LISA cash for reasons other than allowed has been rising.

In 2021/22, there were 47,850 unauthorised withdrawals but this rose 56% to 74,650 in 2022/23, according to the latest HMRC data. A total of £33m was paid in early access charges in 2021/22, with £34m clawed back in 2020/21.

Your options when it comes to cash LISAs

When looking for a cash LISA, it’s important to check not only the overall interest rate but also any bonus rates, which may then fall off at a later date.

The current market-leading cash LISA comes from Moneybox. It can be opened and operated with a minimum £1 via the Moneybox app and pays 4% AER/gross interest. The 4% rate includes a 0.75% bonus for the first 12 months.

The second-best is the Bath Building Society LISA paying 3.74% AER/gross. In third place is the Beehive Money Homebuyer LISA which pays 3.30% AER/gross, a rise from 0.8% in July 2022.

The Newcastle Building Society cash LISA (Issue 3) and the Skipton Building Society’s offering (Issue 4) also both pay 3% AER/gross. All come with a minimum £1 deposit to get you started.

What about investment/stocks and shares LISAs?

There are several investment LISAs to choose from which are more suited to savers who don’t need their cash in the short or medium term.

As the money is invested, these are generally best for those who don’t plan to buy a home soon, or those using a LISA for their retirement.

The following firms all offer investment LISAs:

• AJ Bell
• Nutmeg
• Moneybox
• Hargreaves Lansdown
• Foresters Friendly Society

If you’re choosing an investment LISA you’ll also need to factor in investment fees, which should be shown before you sign up. There’s also the risk, as with any type of investment, that the value of your LISA will go down.